(Photo by Flickr user zack Mccarthy, used under a Creative Commons license)
If you’re a social entrepreneur pursuing a for-profit enterprise, let’s get one thing straight: Venture capital is not always the best option for scaling your business.
Most investors themselves will tell you the same thing.
“If there’s absolutely anything else you can do to get money, do it,” said Jacob Gray, senior director at Wharton Social Impact Initiative, the University of Pennsylvania’s social impact research arm. “VC is really, really tough and comes with a great cost. There’s often a mismatch there of expectations.”
Gray said whenever he’s approached by an entrepreneur looking for venture capital, he tells them two things:
- Look for access to virtually any other funding avenue besides venture capital.
- Still, the very first equity investors should be the three Fs: family, friends and fools. Bootstrapping should never be underestimated as a valuable tool in the entrepreneur’s toolbox.
But if venture capital is what your social enterprise needs to scale, pitch impact investors — a sect of venture capitalists looking for social returns to complement their financial return. From funds and firms to angels, impact investors are unique in their expectations, Gray said, and are steadily growing in numbers.
If you’re a social entrepreneur pursuing a nonprofit model, don’t worry about that: You can’t get your hands on venture capital, anyway. But you can take on debt — even high-risk debt — via loans from institutions like Reinvestment Fund.
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“They are the granddaddy of them all,” Gray said. “They have a strong social mission, they work almost exclusively with debt and they’re like a bank.”
Available for both nonprofits and social enterprises, “impact debt investing” can come in two forms:
- Institutions: These are places like Reinvestment Fund that provide stable low-interest, low-risk loans to entrepreneurs and organizations aligned with their mission.
- Individuals: Individual venture capitalists and angel investors will occasionally offer to take on high-risk debt. Gray said this type of debt is “mostly unsecured with no collateral.”
While it’s a common misconception that for-profit ventures cannot take grants, it’s a funding option for both nonprofit and for-profit models. However, it’s less common for for-profit enterprise because grantors will not receive a tax benefit from the grant. Grants can come from individuals, government, foundations and corporations.
What about bonds? Social impact bonds — also known as “pay for success” — are gaining popularity in the public sector. In a nutshell: Investors fund programs that will achieve benchmark metrics for government, which then puts money back in the pockets of those initial investors. Don’t do it, Gray cautioned.
“That is a horrifically bad way to try to fund innovation,” he said. It’s essentially borrowing money from investors. “They only work on a large scale because the transaction costs are extremely high and very complex.”
Extremely high, indeed. The absolute floor for most SIBs is $15 million, and even then, Gray said they aren’t that very economical.
Besides bootstrapping, Gray said social entrepreneurs across the tax status spectrum can always look to one-off pitch competitions: “You could practically make a living just going from competition to competition at this point.”